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March 17, 2009

Comments

What I haven't seen seriously discussed is the possibility of treating AIG the way we do monopolies that've gotten too big to fail. Split off Financial Products into its own corporate entity. Firewall it off from the divisions of AIG that deal with insurance or with legitimate, capitalized investment, protect them while forcing FP to stand on fall on its own profitability.

Well, this is basically the 'bad bank' approach, which is probably what the government should have done already. There seems a very strong chance they'll eventually end up nationalising many institutions and setting up a bad bank, but having wasted a great deal of time and money in the interim trying not to.

Some people seem to be missing the point concerning the future value of these 'junk' assets: collectively they will surely never be worth their valuation 24 months ago, but many will be worth something, which is infinitely better than nothing, which is what you want to throw them away for now.

which is what you want to throw them away for now

Who wants to do that?

Two points: have we established that the system worked smoothly? If I'm shoveling too much coal into the boiler, can you say that I'm doing my job because the train is running faster . . . right up until the boiler explodes?

In general? I think so. The system worked smoothly since the savings & loan crisis to about 2007. The current breakdown is only a small part of the "system" , and was caused by a self-reinforcing combination of housing bubble, regulatory gaps, and the growth of complex derivatives for mortgage paper. Eliminate any one of those three, and you mostly eliminate the financial crisis.

Look, people who took stupid risks -- like these idiots at AIG -- should be penalized. I'm objecting to the suggestion that we should go beyond punishing incompetents and pushing sound regulatory reforms.

Who wants to do that?

People calling for declaring CDS invalid, or liquidating AIG's 'financial division' and so forth. That is, multiple posts above.

Who wants to do that?

People calling for declaring CDS invalid, or liquidating AIG's 'financial division' and so forth. That is, multiple posts above

Heh. I think a lot of folks (including me) have no idea what actions imply what other actions would have to occur.

As was said, timing is important, as is who is doing what to whom.

many will be worth something, which is infinitely better than nothing, which is what you want to throw them away for now.

Maybe someone can clarify something for me.

There are mortgages. They are worth the revenue stream they generate, discounted by the risk that they will default or be paid early.

Then there are mortgage backed securities. Their worth is related to that of the underlying mortgages, assuming that the value of the underlying mortgages can be discovered.

Then there are CDS, which are hedges against the risk presented by the mortgage backed securities.

I'm *assuming*, perhaps incorrectly, that the CDS are hedges relative to some particular time period. In other words, they are a hedge that the value of the securities will not drop below some value, as of some date, or within some time period.

Is that right?

Also if I'm not mistaken, the relevant time period for the CDS is fairly short term -- a couple of years, maybe, from when they're issued. Maybe less.

If all of this is true, it seems to me that the fact that the original mortgages might be worth something like their face value some more-than-small number of years down the road doesn't do much to relieve the pressure presented by the CDS obligations kicking in.

In other words, if I understand this ugly mess more or less accurately, the fact that a piece of land with a house on it has some intrinsic value has little to do with how screwed we all are in the short term.

Because the not-quite-600 trillion dollar obligation is not mortgages, or mortgage backed securities, but CDS.

And just for laughs, the World Bank puts global GDP in 2007 at $54 trillion. These guys sold obligations more than ten times the value of the entire freaking global GDP.

I'm not sure 'haircut' is the right word.

OCSteve: While we wail over this $165 million what gets lost is: “Goldman Sachs Group Inc and a parade of European banks were the major beneficiaries of $93 billion in payments from AIG -- more than half of the U.S. taxpayer money spent to rescue the massive insurer.” That’s $93 billion (with a B).

I think it's terribly misguided to be outraged over this. Isn't the point of bailing out an over-leveraged firm to allow it to meet its commitments? Wasn't AIG bailed out -- several times -- precisely because its commitments are so widespread throughout the financial system?

And if the objection is that AIG is using its bailout to meet its commitments to nominally 'foreign' banks, that's an anachronistic view of the international financial system. There was a very strong case to be made that nominally 'european' (or 'japanese' or whatever) banks should have been eligible for TARP money in the first place, given their involvement in the American economy. There are no 'national champions' in modern finance, there are only the institutions that matter to your national economy and those that don't.

I would think that government officials were quite aware that much of this money to go to 'foreign' institutions via AIG and other bailed-out 'American' firms, knowing that direct bailouts of 'foreign' institutions would be a PR nightmare with the general public. They likely had no way of figuring out all the intricate relationships before they needed to act to save the system in any case. Either way, as long as the money is percolating through the system, it's at least partly doing what was intended.

many will be worth something, which is infinitely better than nothing, which is what you want to throw them away for now.

Unless I misunderstand (entirely possible) AIG's CDS aren't worthless. Quite the opposite. They're worth a sh*tpile, unfortunately all in the wrong direction as far as AIG is concerned. And when we pay them off the U.S. really doesn't get squat for it.

In other words, if I understand this ugly mess more or less accurately, the fact that a piece of land with a house on it has some intrinsic value has little to do with how screwed we all are in the short term.

A piece of land has no intrinsic value, the market determines it. Currently, there are basically no customers in the market, which means any asset has a current value right now of zero. In the future, unless the apocalypse really happens over the next 12 months, there will be buyers in the market for at least some 'junk' assets in the future.

Also if I'm not mistaken, the relevant time period for the CDS is fairly short term -- a couple of years, maybe, from when they're issued. Maybe less.

Not certain to be honest, but at the very least if you at least retain the staff most familiar with all the hideously complicated risk-spreading devices invented over the past few years, than many can be unravelled and you could theoretically get back to the underlying mortgages and long-term loans.


And just for laughs, the World Bank puts global GDP in 2007 at $54 trillion. These guys sold obligations more than ten times the value of the entire freaking global GDP.

This phenomenon is typical, even if the ratio was especially high recently. Financial institutions' obligations always exceed their immediate assets by various multiples, under the assumption that they do not need to meet all those obligations at once. This is the basis of the modern economy: I borrow now to build a factory that makes super-widgets, knowing that over the next twenty years those super-widgets will make more than enough money to pay that loan back. In a sense then, I am assuming the debt of the next twenty years' worth of my economic activity. Extend this principle throughout the economy, and the economy is always indebted, almost by definition, by whatever multiple of its current total value.

They're worth a sh*tpile, unfortunately all in the wrong direction as far as AIG is concerned. And when we pay them off the U.S. really doesn't get squat for it.

You get a lot for it if it means those so-called 'foreign' institutions start extended loans in America again. That is the whole point of this: to get the financial system working again to the benefit of the American economy.

I can guarantee you that many irritating people will benefit from this, and that many foreign entities will benefit from it. However, if you get the American economy going again in a reasonable period of time within reasonable expense then you have done a good job, and saved many American citizens' livelihoods.

If, on the other hand, your primary goal is to punish those you feel responsible, the American economy will suffer for it, and more Americans will lose their jobs.

Smug scumbags will do ok, there's little we can do about that (they always will); our concern to make sure we do ok too. Baby/bathwater, nose/spiting face etc.

Consider how you'd feel if there was a secret right-wing list channeling policy views from The White House to AP reporters who cover the Middle East the rest of the country. Are you going to have confidence in those reporter? In Fox News?

Fixed that for you, von.

Since you asked in seriousness, though, I would point out that "lists" like these already exist on the right, groups aimed at disseminating right-wing policy views and talking points to the media. Conservatives usually call them "think tanks", although I'd be hard-pressed to vouch for how much thinking goes on in them based on their product.

Wow. So many good comments I'd like to address since I first saw this thread at 2:30 a.m. (hilzoy: How is it that you always post these 2 a.m threads when I can't sleep?)

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($19000 per lower level AIG person amounts to what a Dallas Cowboy would pay in tips during a week in Aruba, but nobody's calling for their heads)

Wrong. Jerry Jones, not taxpapers, are paying bonuses to the Cowboy in question.

A piece of land has no intrinsic value, the market determines it. Currently, there are basically no customers in the market, which means any asset has a current value right now of zero. In the future, unless the apocalypse really happens over the next 12 months, there will be buyers in the market for at least some 'junk' assets in the future.

This seems to be the whole fallacy of the rational market. If markets were "rational" something that has a future value would also have a current value.

Rational markets would have longterm valuations, so companies like Microsoft and GE would not have huge changes in values during even long recessions or depressions, because the future value would continue to be higher than it is now.

I can see how changes in a market would effect the long term value of weaker companies that might not survive a downturn, but I don't see how it is rational to value those with good long term prospects lower in the short run.

russell, the extent of CDS obligations that AIG is liable for is more like $400 billion, with a 'b'.

I understand that you may be concerned with the larger picture, but we're talking AIG for the nonce. If AIG goes under, then it's domino time.

As I understand it. I could be wrong, though.

"This seems to be the whole fallacy of the rational market. If markets were "rational" something that has a future value would also have a current value.

Rational markets would have longterm valuations, so companies like Microsoft and GE would not have huge changes in values during even long recessions or depressions, because the future value would continue to be higher than it is now."

Aren't Depressions considered pretty much irrational overreactions in the 'keep my money safe under the bed' kind of way just like bubbles are overreactions in the 'if I don't invest in real estate I'll never be able to afford a home' kind of way?

Yes it is a market failure. It is a human failure.

I share the temptation to form a pitchfork mob over payments to those AIGFP bastids... but I gotta say, it blows my mind that *this* snowballs into a big public outrage, yet the whole ICRC leaked report on US torture gets the public equivalent of "meh."

or am I missing something?

A piece of land has no intrinsic value, the market determines it.

Not to quibble, but just to ground this discussion in some kind of tangible reality -- the only thing in all of this that has intrinsic value is the real property.

The entire economy might crash around our ears, such that it will take a suitcase full of $100 bills to buy a half pound of dry beans, but a piece of real property with a house on it will still feed you and keep you dry when it rains.

Just saying.

Financial institutions' obligations always exceed their immediate assets by various multiples, under the assumption that they do not need to meet all those obligations at once.

Yes, I understand that.

When the CDS were sold, what was the value of the immediate assets of AIG?

What was the ratio of that number to the value of the GDP of the entire world, let alone ten times that number?

How does that ratio compare to the likelihood that the scenarios they were offering hedges against would never happen?

What AIGFP was selling was a promise to pay if the hedge conditions occurred. They did not have the ability to pay.

Who has ten times global GDP in the bank?

There was a measurable likelihood that the hedge conditions would occur, otherwise they would have no customers.

Who would buy insurance against something that will never, ever happen?

I call this fraud. Let me know where my analysis falls down if you think otherwise.

IMVHO, these guys should go to jail. Instead, you and I might be paying them millions.

Some people seem to be missing the point concerning the future value of these 'junk' assets: collectively they will surely never be worth their valuation 24 months ago, but many will be worth something, which is infinitely better than nothing, which is what you want to throw them away for now.

You're not getting it. I'm sorry, but you just seem to be failing to grasp the scope of the failure here, and in fairness you're not alone.

The question we should really be asking is, what are credit default swaps and similar derivitaves? I don't mean what are they in the sense of how they work, I mean what kind of financial instrument are they, legally? What kind of asset, property, liability? Until we know what they are, nobody can really decide what to do with them. Are they insurance? Stocks? Mutual funds? Gambling receipts? They're very obviously not some of these things, but no one has yet been able to explain how you determine the worth--or even the existence--of an instrument that claims to back another instrument that claims to back an arbitrary and artificial chunk of a pool of debt.

I can't recommend loudly enough what russell said here:

How much did they sell? Last year the Bank for International Settlement valued the value of the commitments represented by credit default swaps at $596 trillion.

In the fall of 2007 the value of all publicly traded equities on world exchanges was $62.5 trillion. A year later, last fall, it was $36.6 trillion.

They sold commitments to pay somewhere between 10 and 20 times the total value of all of the publicly traded equities in the world.

In the whole m****rf***ing world.

STOP.

Before you read or write another word on this subject, stop and think about that.

Someone elsewhere raised the following point:

The two choices seem to me to be that CDSs are either (a) essentially a form of insurance, that we could declare void because the issuers were not properly regulated, etc. (and then, if we are so inclined, set up reserve requirements, etc. to allow them to go forward) or (b) essentially a form of wagering contract, which we can declare void on the same theories that various states have declared wagering contracts void since time out of mind.

These people figured out how to print money. That's what they did. That's all they did. It's all well and good to say that we can't allow this to fail or that entity to fail, but at a certain point what this amounts to is that a huge portion of the world economy is based on imaginary assets that do not exist and will never exist, and that unless we want to go full-steam into hyperinflation there is no way we can mint enough money out of thin air to back all of these fraudulent instruments.

Fired? The people responsible for opening this Pandora's box will be lucky if they get through 2009 without being dragged from their desks by an angry mob and hung from the nearest street sign. The only thing stopping it is that most people don't realize just how bad this is or how deep the rabbit hole goes.

Before you read or write another word on this subject, stop and think about that.

What I've heard on this is that CDSs were actually written bidirectionally, so commitments offset. You owe me a trillion, plus or minus, and I owe you a trillion, plus or minus, and the obligations cancel, approximately.

Is this incorrect? The amounts aren't important; that they are in balance is. AIG only sold CDSs; they didn't buy them as (and again, this is how I understand it) nearly everyone else was doing.

Link to the CDS explanation. Probably not the first time anyone has linked it.

...and if this interpretation is correct, Catsy, there is no such imaginary assets on the scale you're talking about, because they're mostly balanced out by liabilities to result in nearly zero net assets.

What I've heard on this is that CDSs were actually written bidirectionally, so commitments offset. You owe me a trillion, plus or minus, and I owe you a trillion, plus or minus, and the obligations cancel, approximately.

While some may have been, I haven't seen anything to indicate that was the case for the vast majority.

Is this incorrect? The amounts aren't important; that they are in balance is. AIG only sold CDSs; they didn't buy them as (and again, this is how I understand it) nearly everyone else was doing.

It's not that simple. Let's assume that Bob's balance sheet is neutral because they have sold $1000 in CDS's and bought the same amount. That doesn't mean that Bob made a 1:1 exchange of CDS obligations with Frank, it could mean that Bob sold $700 of CDS's to Frank but $300 to a bunch of other people, bought $300 each from Frank and Paul, and bought $400 from Steve.

That's all well and good until Frank defaults. Suddenly Bob has to pay Frank his $700, but even if the $300 they owe each other cancels out, that still leaves Bob $400 in the red.

The chances of all of these balance sheets being symmetrical or even close enough to it to make the CDS market not be a catastrophe are so minute as to barely merit thought.

Does this mean that the folks on Wall Street deserve credit when the system works smoothly? Because that would be worth a great deal in compensation, given the importance of the job.

Does that follow?. Sure, the system is important and they deserve credit when the system works smoothly. Hospitals are important, too and the people who work there deserve credit when things go smoothly. The same is true of fire and police departments, public schools, garbage collection, the electric company, and on and on.

Yet that doesn't mean that we routinely pay people in those places millions of dollars, even though they work plenty hard.

The normal argument for huge pay differentials is not the importance of the task (how important to society, really, are professional athletes?) but the scarcity of the necessary talent.

Does this hold in the case of Wall Street? Are all those people so incredibly talented and smart? Or are lots of them just reasonably intelligent types who managed, somehow or other, to get into the game? I'm open to (non-circular) arguments that they really are scarce, but have a strong presumption that they are not.

...and if this interpretation is correct, Catsy, there is no such imaginary assets on the scale you're talking about, because they're mostly balanced out by liabilities to result in nearly zero net assets.

ha ha. But seriously, catsy, "You're not getting it. I'm sorry, but you just seem to be failing to grasp the scope of the failure here, and in fairness you're not alone" -- it kinda seems like you're mostly floored by the notion of abstract intangible assets, which superseded tangible assets in value a very long time ago (like 19th century, at least surely).

These people figured out how to print money.

Well, anything is 'money' that can be traded. And the whole point of financial institutions is to create 'value' out of thin air by dint, essentially, of playing with time rather than relying on the here-and-now, which translates into buying and selling risk, because no asset is truly 100% safe (not even tangible assets like houses and, especially, bank notes). The various exceedingly-complicated risk-spreading devices they come with in recent years certainly are complicated, but there is no indication that they are somehow fraudulent, at least not generally speaking. There's no indication that they somehow deceived buyers about the nature of the assets, beyond good salesmanship etc.

That said, it seems uncontroversial to say that this things should have been regulated better. Perhaps they should have been banned outright, but that doesn't mean they were somehow dishonest, just unstable once they became a sizable chunk of the market.

Heck, by that logic you could say houses and apartment should be illegal, because if enough people start buying and selling them, the market becomes unstable and crashes.

What I haven't seen seriously discussed is the possibility of treating AIG the way we do monopolies that've gotten too big to fail. Split off Financial Products into its own corporate entity. Firewall it off from the divisions of AIG that deal with insurance or with legitimate, capitalized investment, protect them while forcing FP to stand on fall on its own profitability.

Once again, YOU CAN NOT DO THIS. These liabilities were assumed by AIG as a whole. ALL of the divisions, collectively, are responsible for them. People signed contracts with AIG on the knowledge that the company, not the Financial Products Division, was standing behind them. It's just like any other bankruptcy.

You can not take a bankrupt company, and put the good stuff into one entity, and the bad stuff into another, and not let the good entity pay the debts of the bad one. The creditors WILL sue, and they WILL win. That's the underlying basis of all of bankruptcy law: the creditors line up, and based upon the levels of seniority of the debt in the original contracts, they get paid in proportion to the companies assets.

You can't run a bankruptcy system on any other basis. If you do, you will see the price default risk on ALL liabilities skyrocket.

Russel : Not to quibble, but just to ground this discussion in some kind of tangible reality -- the only thing in all of this that has intrinsic value is the real property.

The entire economy might crash around our ears, such that it will take a suitcase full of $100 bills to buy a half pound of dry beans, but a piece of real property with a house on it will still feed you and keep you dry when it rains.

I'm not denying that a house will keep you dry in the rain whereas a CDS will not (unless it's printed on very large laminated paper). However, the belief that property has some magic intrinsic value that paper money or any other kind of asset doesn't is precisely the reason for a constant cycle of property booms and busts in most modern economies. This last one happened because capital fled from more abstract assets following the dot-com boom into housing, all in the false belief that property somehow has more 'real' value.

The chances of all of these balance sheets being symmetrical or even close enough to it to make the CDS market not be a catastrophe are so minute as to barely merit thought.

Sure. But in the meantime, the total amount of CDSs written in your example is $2000, which means the total amount of faux-ness in assets is 25% of the total CDSs written.

What do you think the odds are that there are that few transactions out there? The more transactions, the more those assets, as computed by russell's cite, appear to inflate.

These people figured out how to print money. That's what they did. That's all they did. It's all well and good to say that we can't allow this to fail or that entity to fail, but at a certain point what this amounts to is that a huge portion of the world economy is based on imaginary assets that do not exist and will never exist

Catsy nails it. We live in a credit based economy, not a money based economy. Steve Keen explains this far better than I can. Credit policy is the lever of power in fact which monetary policy merely claims to be. The wizards on Wall St. obtained (via the shadow banking system) the keys to the printing press. Now we have to decide how to handle all the liquidity they created out of nothing - do we destroy it (thereby strangling the economy), do we honor it (thereby either triggering hyperinflation or indebting ourselves for the next 20-30 years at barely sustainable levels of debt service to GDP ratios), or some combination of the two.

That is the crux of the problem.

You can not take a bankrupt company, and put the good stuff into one entity, and the bad stuff into another, and not let the good entity pay the debts of the bad one.

You certainly can, that's what a 'bad bank' is, a very common governmental response to a financial crisis such as this.

Naturally, you don't tell the creditors to go stuff themselves, unless things have gotten really terrible I suppose. Perhaps you might placate them with giving them less than 100 cents on the dollar. Either way, you hope that the big bag of lousy assets the taxpayer now owns might prove worth something in the end, as the usually do in fact, though undoubtedly less than their pre-crash value.

In the meantime, the loss the taxpayer has incurred is hopefully greatly outweighed by avoiding greater damage to the broader economy, which is basically the entire point of a bailout.

and

The two choices seem to me to be that CDSs are either (a) essentially a form of insurance, that we could declare void because the issuers were not properly regulated, etc. (and then, if we are so inclined, set up reserve requirements, etc. to allow them to go forward) or (b) essentially a form of wagering contract, which we can declare void on the same theories that various states have declared wagering contracts void since time out of mind.

No. No, no, no. We can decide these things going forwards. I absolutely agree that we should consider credit default swaps to be insurance, and regulate them as such. I've seen a number of interesting ideas on how to do this.

We can not decide that the CDS that were previously sold are insurance, and should be regulated as such. There were existing laws as to how to treat them: as derivative contracts based upon the price of an underlying asset, but not requiring any connection to that asset.

What you people are saying is that we should retroactively change the law. You would be telling the financial markets that they may KNOW exactly what they are buying, but the government reserves the right to tell them years later that they were ACTUALLY buying something completely different. There would be no way to price anything, because there is always the possibility that it's something other than what the contract says.

This is an absolutely INSANE idea. Yes, it would feel really nice to do, but it has long range consequences that are very bad. It's Sean Hannity level stupid.

The wizards on Wall St. obtained (via the shadow banking system) the keys to the printing press. Now we have to decide how to handle all the liquidity they created out of nothing

IMHO, they created 'value' and value is subject to perception. Hence they can't have created any assets without customers. My feeling is that the two recent, interconnected bubbles are the result of formerly communist/socialist/nationalist economies in the east and in the developing world switching to western-style capital-based economies towards the end of the Cold War and afterwards.

New industrial titans like China and commodity-producing countries have produced far more capital than their own economies can absorb (in previous years they would have been forced to absorb most of that capital output, in very inefficient fashion, by their socialist/communist governments) and all that cash has rushed into dot-coms and property bubbles and so forth in the West (in addition to making up the difference of government expenditures in the USA and elsewhere).

Ultimately though, I suppose it must originate with productivity growth in East Asia, as productivity growth is the only real way to make more wealth.

Can we at least stop and agree that contracts should be handled according to the laws as they existed when the contracts were written? If you want to extinguish debts, there is a prescribed method: bankruptcy. For a variety of reasons, I don't think that bankruptcy for AIG is a good idea, but if you want out of the contracts, stop trying to be clever and manufacture loopholes. Just advocate the method that already exists.

What you people are saying is that we should retroactively change the law. You would be telling the financial markets that they may KNOW exactly what they are buying, but the government reserves the right to tell them years later that they were ACTUALLY buying something completely different. There would be no way to price anything, because there is always the possibility that it's something other than what the contract says.

Doesn't this depend on how strongly you forcibly modify the terms of the contract? If what you thought was a salmon, I come along later and say in effect "no, that is actually a tuna", then at least we are still talking fish (and can make sushi out of it). On the other hand if I say "actually, you are possesion of a bicycle", well then we have a bit of a problem now, don't we?

Niall Ferguson recently wrote that the best way out of this mess is via massive debt conversion and writedowns, and he cites as historical precedent the 19th century practice of "conversions" whereby fixed rate bonds were unilaterally modified downwards with regard to their rate of return (e.g. from 5 percent to 3 percent). This strikes me as a similar sort of forced post-facto modification of a financial contract, and yet the 19th cen. financial system did not implode as a result of this practice.

So it seems to me that the question is not whether CDS contracts can be modified without causing TEOTWAWKI (the end of the world as we know it), but rather how severely can they be marked down without triggering a catastrophic decline in confidence regarding future contracts.

Also, it seems to me that having complete, utter 100 percent confidence in financial contracts was part of the problem which helped build this mess in the first place via the practice of "financial engineering". If our erstwhile engineers of finance have to take into account in the future that contracts may not always be honored under any and all circumstances, is that really a bad thing from a systemic risk standpoint? Because from my point of view it seems obvious that a more sustainable financial system will need to incorporate better scenario analysis into contracts, just as real engineers have to take material failures into account when building things. If you have to assume that certain things (like the sanctity of contracts) never fail, then you shouldn't be permitted to build anything really large or essential based on those assumptions.

Pitch forks through the abdomen is too kind for these guys. Federal prison in a cell with a beefy Dirk Diggler would be more like it. No free condom hand-outs either, for that might promote illicit sexual behavior. And Jesus wouldn't want that, would he?

I'm all for pay-for-performance.
The Financial Services division of AIG lost billions.
Sounds like they owe money.

What you people are saying is that we should retroactively change the law.

You misunderstand. What I am saying is not that we should retroactively change the law. What I am saying is that before we can even decide what part of the law to apply, we have to decide what part of the law applies. I don't think it's as obvious as you do that the correct action is to treat junk CDS's as "derivative contracts based upon the price of an underlying asset, but not requiring any connection to that asset". There are derivatives in finance that fall neatly into established and regulated categories and that are not themselves problematic. These are not what I am referring to.

What I am referring to are the instruments that effectively amount to insurance policies on an abstract block of debt.

We can not decide that the CDS that were previously sold are insurance, and should be regulated as such.

You say this is so, but why not, if that's what they were?

What it sounds like you're saying is that if I figure out a new way to sell insurance against a given type of loss, call it a fancy new name so that it doesn't fall under any existing regulatory regime, and claim it's not insurance, I can sell it free of oversight or accountability--as long as I don't call it insurance. And that the government has no ability to step in after the fact and point out that no, these are still functionally and legally insurance policies, no matter how you re-brand them or obfuscate their nature.

Bull***. I call bull****. The fact that Wall Street got away for years with misrepresenting the nature of CDS's in order to do an end-run around regulations does not immunize those instruments from being reevaluated in light of what we now know.

Can we at least stop and agree that contracts should be handled according to the laws as they existed when the contracts were written?

Somewhat separate from the CDS issue (itself the threadjack), but no--we cannot all agree on that, and we'd be stupid to do so, not if what you mean by that is "suck it up and pay the bonuses". Contracts get modified in legal proceedings all the time.

What I am saying is that before we can even decide what part of the law to apply, we have to decide what part of the law applies.

This is what happens when you copy and paste one too many times. This should read:

What I am saying is that before we can apply the law, we have to decide what part of the law applies.

You say this is so, but why not, if that's what they were?

That would be great, if that was what they were, but legally, it is very clear that they were not. The law specifically allowed CDS to be traded among people who did not own the underlying asset. This means that they had no insurable interest. If they had no insurable interest, then, under long-standing Anglo-Saxon law, they can't purchase insurance. The fact that they were allowed to buy the contracts means that, under Anglo-Saxon law, THEY CAN NOT BE INSURANCE. Your insistence otherwise is contrary to the law. You want to violate the contracts.

TLTIA: My argument has not been that CDS contracts can't be modified. I've been trying to tell people that they can't be voided. They are real, legitimate, enforceable contracts. Making them just disappear would be contrary to the rule of law.

Catsy,

I think Congress passed a law which the president signed that expressly says CDS 'bets' are not insurance, I think the Commodity Futures Modernization Act. I think they answered your question about what it is dishonestly, but that's what they said in the CFMA (unless I misunderstand).

Which, I think, merely goes to show that the conspiracy to create and run a criminal gambling enterprise was not limited solely to the bookie (AIG) and the degenerate gamblers (purchasers of swaps who do not own any portion of the underlying asset), but also included the approval and protection of the Mafia/organized crime (Washington, DC).

Here's some stuff from the CFMA 2000 wiki:

The Commodity Futures Modernization Act of 2000 or CFMA (H.R. 5660 and S.3283) is United States federal legislation which repealed the Shad-Johnson jurisdictional accord, which had banned single-stock futures in 1982. The legislation also provided certainty that products offered by banking institutions would not be regulated as futures contracts.

J. Michael Neal,

That would be great, if that was what they were, but legally, it is very clear that they were not. The law specifically allowed CDS to be traded among people who did not own the underlying asset. This means that they had no insurable interest. If they had no insurable interest, then, under long-standing Anglo-Saxon law, they can't purchase insurance. The fact that they were allowed to buy the contracts means that, under Anglo-Saxon law, THEY CAN NOT BE INSURANCE. Your insistence otherwise is contrary to the law. You want to violate the contracts.

Where is it in the CFMA that congress legalized gambling? For instance, if New York State wants to shut down some bookmakers in the state and seize what it can from them and send them to jail, is the CFMA going to pre-empt this action because it legalized gambling? Same question and insert "AIG" for "bookmaker"?

In other words, the CFMA said these CDS are not insurance, but so what? It's really gambling, not insurance, and it always had been.

OT again, on JournoList: von:

"By Ezra's own telling, it's a "center to left" list that provides information from selected center to left policy experts to journalists -- including journalists purportedly doing "straight" news. It's the dissemination to "straight" news journalists that is the problem, not the existence of the list itself. If that doesn't sound problematic to you, you need to think harder about the issue."

It does not "provide information" except in the following sense (and note: I'm using lawyers as an example here b/c JList is mostly not lawyers): imagine a listserv whose membership was composed of legal scholars, some of the wonkier legal journalists, and some of the wonkier legal bloggers (e.g., Balkin, Sandy Levinson.) When legal issues come up, they get into furious arguments: Levinson v. Scott Lemieux on constitutional arrangements, Balkin v. Sunnstein on originalism, Tribe v. someone else on the second amendment, with Dahlia Lithwick and Nina Totenberg popping up to make points every now and again, and people like Mark Kleiman chiming in with empirical evidence. Imagine that people cite evidence for their claims, and that there is nothing resembling a party line.

Now modify this example to reflect the fact that since I'm not a lawyer, all the legal scholars I can think of are fairly well known, whereas the same is not at all true of JList (meaning: dilute the famousness factor by an order of magnitude.) Also, imagine that about a third of the time, people argue about entirely unrelated things, like the virtues (or lack thereof) of various rock bands, the final four, etc.

I'm not seeing why this is problematic.

They are real, legitimate, enforceable contracts.

This is true, but it misses what seems to me to be a basic point:

Who is going to pay?

AIG wrote something like $440 billion of CDS. That's *just* AIG. And they didn't buy any, so in their case there is no counterbalancing balance due.

Who's going to write a $440 billion dollar check?

And how many more AIG's are there out there?

Debra: "...but even I am aware of the fact that the stock exchange is NOT capitalism, and that it has been abolished at different reprises in the history of the United States (don't ask me for dates, go looking, they are there, and I am no good at keeping numbers in my head...)"

No, I'll ask you, since it's your assertion. I'd really like to know when "the stock exchange... has been abolished at different reprises in the history of the United States."

You're aware of it, you say: please give a link to support your assertion. Either it's a fact, or it isn't. If it isn't true, it's not helpful to claim that things that are false are true. If it is true, you can support your assertion. Thanks.

Getting a little tired of going round and round and having the core contention here ignored, but what the hey.

They are real, legitimate, enforceable contracts.

Not if they are fraudulent in nature.

Making them just disappear would be contrary to the rule of law.

Not if they are fraudulent in nature.

The law you keep going on about will not enforce a fraudulent or misrepresented contract. You keep telling me that I want to violate the contracts and telling me what I want is contrary to law, but these assertions are predicated on the assumption that these CDS's are legally and contractually airtight.

It is neither obvious nor a given that this is a fact.

I share the temptation to form a pitchfork mob over payments to those AIGFP bastids... but I gotta say, it blows my mind that *this* snowballs into a big public outrage, yet the whole ICRC leaked report on US torture gets the public equivalent of "meh."

or am I missing something?

The financial mess threatens the vast majority of the middle class. Torture threatens Other People, a tiny number of Mooslim terrists.

Most people don't pay much attention to stuff that threatens Other People, let alone a perceived despised, feared, hated, minority.

They are real, legitimate, enforceable contracts.

This is true, but it misses what seems to me to be a basic point

russell,

You and TJ have really had a good run in this thread. FWIW, I think you 2 are onto the crux of the whole AIG/CDS matter. But I'm not sure if I agree that CDS written when their was no ownership interest in the underlying asset are magically real, legitimate and enforceable contracts. And part of the reason why I'm not so sure has to do with your question, "Who's going to pay?"

In one sense, a CDS in which the purchaser does not own any of the underlying assest is just as real, legitimate, and enforceable as the "contract" I have with the guy who took my NCAA bracket for the pool I entered. I'll probably get paid, but, in these times, there is a chance the bookie takes the money and runs. But it's a risk and it's a risk that I already know isn't insulated by the law. Because gambling is illegal.

And, because gambling is illegal, no one I know has an expectation that their gambling activities create "enforceable contracts" between their degenerate selfs and their degenerate bookies. Such an expectation would be stupid and unreasonable. They figure if the bookie won't pay out, about all one can do is chalk it up to a learning experience and try to find a more honest bookie, or better yet, quit gambling.

It's just as stupid and unreasonable in the CDS context. Expecting you have anything "enforceable" against your bookie when your bookie agrees to cover your million dollar wager on the Friday football game in Dillon is stupid. Your bookie lives down by the river. You can't reasonably expect he's going to pay and you can't reasonably expect that the law would care.

Expecting you'll either get paid or have the assistance of the law in getting paid from the bookie (AIG) who has taken on $440 billion worth of bets is equally stupid.

AIG and it's counterparties aren't stupid, they just figure they've got the mob (U.S. Government) to back them up. So far, they've been correct. I'm with russell, I think it's time to give them a re-think in the form of voiding all CDS where the purchaser doesn't own the underlying asset.

"imagine a listserv"

Listservs have been around for decades, for every possible group of people.

Film at 11.

Anyone outraged by that fact is a moron.

Fixed that for you, von.

But, Catsy, you're proving my point. Because Fox News has been exposed as repeating Bush talking points, Fox's credibility takes a huge hit -- and rightly so. The fact that other straight-news journalists are on JournoList means that their credibility should also take a hit. So, c'mon: give us the names.

Since you asked in seriousness, though, I would point out that "lists" like these already exist on the right, groups aimed at disseminating right-wing policy views and talking points to the media. Conservatives usually call them "think tanks", although I'd be hard-pressed to vouch for how much thinking goes on in them based on their product.

OK; and if these lists are intended to disseminate left and left-of-center ideas to journalists who purport to be apolitical, let's get those lists exposed too.

Again, having a list that feeds fellow partisans is one thing. Having a list that also feeds journalists is something quite different.

"left and left-of-center" ideas ==> "right and right-of-center" ideas. I forgot which list I was writing about.

OK; and if these lists are intended to disseminate left and left-of-center ideas to journalists who purport to be apolitical, let's get those lists exposed too.

I got the idea that content was a lot broader than this and the function was broader as well.

J Michael Neal on voiding CDS:

This is an absolutely INSANE idea. Yes, it would feel really nice to do, but it has long range consequences that are very bad.

It's "INSANE" for governments to discourage gambling? All the states that outlaw it are "INSANE"? Because gambling is such a tremendously productive economic activity? Perhaps gambling is even more productive for the citizens and their economy when the gamblers and the bookies can just take gambling losses and socialize them. Putting $$$s citizens could have productively spent or saved to pay gamblers and bookies for their stupid bets. Something does seem "INSANE", but it's mostly your "whatever happens in Vegas stays in Vegas and everybody else has to pay for it" thinking.

Let me see if I understand approximately where you were headed with your argument. Is it that if we don't allow these transactions to happen then, as a long-range consequence all this tremendously productive gambling activity will have to head to Monte Carlo (London/Dubai) and then where will our economy be?

Because I don't know the answer but, despite your dire warning about "consequences", it's something I'd like to find out.

"I got the idea that content was a lot broader than this and the function was broader as well."

Anyone who has been on a listserv knows that they exist for people to chat, ask questions, and argue.

Nobody gets brainwashed from them any more than they get brainwashed by discussions in a blog comment thread. They're more or less identical phenomena.

Of course there are journalistic listservs. There are listservs of all sorts for every possible interest. There are plenty of lawyer listservs. Since when is this news to anyone with the faintest clue about the internet?

"It's 'INSANE' for governments to discourage gambling? All the states that outlaw it are 'INSANE'?"

That's arguable, yes. For one thing, it's pretty much impossible to outlaw gambling. All you can do is drive it underground.

In other words, the CFMA said these CDS are not insurance, but so what? It's really gambling, not insurance, and it always had been.

No. Go read the Gramm-Leach-Bliley Act
, which established the laws for this. Section 206 defines swaps as Identified Banking Prodcuts. It says that they are covered under the rules for investment products, and specifically allows banks to sell them. Section 301 starts the section on insurance regulations. It says that national banks are not allowed to sell insurance products.

CDS are not insurance. They should be, but they aren't. Alternatively, I wouldn't object to them not being considered insurance products if they were exchange traded. The rules for what is permissible in exchange trading are more strict, because exchange trading avoids exactly the problem we have: counter-parties being beholden to a particular company in order to get paid.

CDS are also, legally, not gambling. I agree that the line between gambling and a lot of different financial products is hard to see in the abstract, but they are different under the law. Like it or don't, but the law is clear.

Can we all at least agree that it is refreshing to have a new profession to hate even more than lawyers?

I know I get a lot of joy out of picking on my MBA/financial wizard friends for causing the downfall of civilization.

Q: How do you know we have too many MBA's?

A: You are in a depression.

But, Catsy, you're proving my point.

No, I was just snarking. The idea of trying to make any kind of serious comparison, on any level, between Fox News and a DL for journalists to flabble about policy makes me snicker loudly enough to annoy my coworkers. That's why I contrasted my "fixed" snark with the "in seriousness" in the next paragraph.

OK; and if these lists are intended to disseminate left and left-of-center ideas to journalists who purport to be apolitical, let's get those lists exposed too.

Again, having a list that feeds fellow partisans is one thing. Having a list that also feeds journalists is something quite different.

Why? Do you really think it's appropriate to insist we know what DLs every journalist is on, regardless of what political stripe they wear? Don't get caught up in the kind of melodramatic, liberal-media, left-wing conspiracy verbiage that people seem to be using about this, this isn't a transparency issue like Cheney's energy task force. Call this what it is: a demand to know what Internet mailing lists journalists subscribe to.

I mean, seriously? Can I also demand to know what blogs they read, if they visit 4chan, or what Counterstrike servers they play on? I'll bet Nedra Pickler gets her scoops from Drudge, and Novak's a CT teamkiller if I ever saw one.

The law you keep going on about will not enforce a fraudulent or misrepresented contract. You keep telling me that I want to violate the contracts and telling me what I want is contrary to law, but these assertions are predicated on the assumption that these CDS's are legally and contractually airtight.

It doesn't matter whether or not fraudulent contracts can be enforced, because these contracts were not fraudulent. You can wish that they were fraudulent all you want, but they weren't. Not legally. I agree that that demonstrates that the law was bad, but it was still the law.

CDS were not insurance products. They weren't subject to the regulations that insurance products were. One of the consequences of that is that reserve requirements for them weren't the same as they are for insurance policies. Under the reserve requirements that did exist for them, AIG was not legally required to ensure that it was capable of paying out all of the contracts it sold, just as you are not required to have all the money to purchase a house at the time you buy it.

The remedy for this is bankruptcy. Short of that, these are enforceable contracts. Again, you can wish all you want that the laws were different, but you'll get that about the same time you get your pony.

Let me see if I understand approximately where you were headed with your argument. Is it that if we don't allow these transactions to happen then, as a long-range consequence all this tremendously productive gambling activity will have to head to Monte Carlo (London/Dubai) and then where will our economy be?

No. I mean that the people who buy and sell ALL investment products will see that the government can simply void their contracts when it so chooses. Given that CDS are covered under the same investment laws as shares of stock you buy, if the government has the power to void your CDS contract, then it has the power to void your shares of stock. It has the same legal basis for either.

I like Obama as much as anyone, but I think that it is a crazy bad idea to allow the government to void investment contracts. Remember that you would be giving the power to all future governments as well.

Because I don't know the answer but, despite your dire warning about "consequences", it's something I'd like to find out.

On a related note, I often look down from the Hennepin Avenue bridge, and wonder what it would feel like to jump off. I don't actually know the answer to that. It's something I don't want to find out.

"if these lists are intended to disseminate left and left-of-center ideas to journalists who purport to be apolitical"

This one is "intended to disseminate information" only in the sense that if you have me on a listserv and you ask a question about stem cells, I will probably reply. Dissemination involves some sort of recognized source from which things are disseminated. This list does not have one, unless someone responding to a question, or disagreeing with a comment, counts as that person "disseminating". It has a bunch of policy wonks and various experts and bloggers and some journalists of the sort who would be interested in a wonky list.

It doesn't matter whether or not fraudulent contracts can be enforced, because these contracts were not fraudulent.

You keep asserting that as if it's a settled fact. You can write the words as many times as you like, but it doesn't make the argument any more sound to anyone who doesn't share this fundamental assumption of yours.

I give up. You're obviously convinced to the point of faith that CDS's are legally airtight under the laws and regulations that existed at the time, and that there was no fraud or misrepresentation involved. Go forth and believe with my blessing, if that's what you're waiting for.

Expect to see that question play out on the public stage before the year is out. Better minds than yours or mine will determine which way it will get decided, but given how much we don't yet know about the CDS market, and the kinds of things that keep coming to light, I wouldn't yet place any bets on it either way. Well, unless that bet is a credit default swap.

"This list does not have one, unless someone responding to a question, or disagreeing with a comment, counts as that person 'disseminating'."

If it's like any other many-to-many email list in existence on this planet, any statement that is remotely contestable or controversial or arguable is argued with by someone.

J. Michael Neal, I salute you, you are almost the sole source of reason on this thread. Talking about the financial industry as 'fraudulent' or 'gambling' is neither accurate nor productive (and also parochial, gambling being legal in most modern financial economies, whose health your job also depends on).

CDSes are valid legal financial assets, albeit ones that almost certainly warrant more rigourous regulation than they have thus far received. They are very complicated, particularly as practiced with gusto by AIG.

As a consequence, practically no one understands AIG, so when everything was going south there last year, some sensible person went to the people running these assets at AIG and said "we need you; without you this company implodes. Here, we promise to give you this retention bonus because we need you to stick around."

Deeming AIG too big to let fail, the US federal government spends $170 billion keeping the firm afloat. Now people are up in arms about the relative chicken feed promised to the very people that give AIG its value. Driving these people away will lead rapidly to AIG's failure which, even if you decide is acceptable, was surely more desirable before the US federal government borrowed $170 billion to own it.

A significant side-effect of reneging these contracts will be to tell the world that once the government is involved in an institution, contracts aren't worth the paper they are written on. With the government's involvement in the financial sector growing by the day, this fear will greatly intensify the calcification of the credit markets -- the exact opposite of the desired goal.

This way madness lies, and the loss of many people's jobs.

You keep asserting that as if it's a settled fact. You can write the words as many times as you like, but it doesn't make the argument any more sound to anyone who doesn't share this fundamental assumption of yours.

I give up. You're obviously convinced to the point of faith that CDS's are legally airtight under the laws and regulations that existed at the time, and that there was no fraud or misrepresentation involved.

The burden of proof is certainly on you. I find it unlikely that an entire category of extremely popular financial products was inherently fraudulent, though perhaps genuine cases of fraud will come to light. The only accusation you have leveled against CDSes thus far is that they represent complex bundles of risk, which is entirely the point of the financial markets.

It is certainly possible that an individual CDS was fraudulent. If the seller made a false representation to the buyer, that might do it, depending upon what the specific misrepresentation was. In general, though, CDS are not fraudulent. They are clearly covered by the language of the GLB Act. They have survived court challenges. See, among others:

VCG Special Opportunities Master Fund Limited v. Citibank

Merrill Lynch Int'l v. XL Capital Assurance Inc.

I give up. You're obviously convinced to the point of faith that CDS's are legally airtight under the laws and regulations that existed at the time, and that there was no fraud or misrepresentation involved. Go forth and believe with my blessing, if that's what you're waiting for.

Yes, I will believe that, because I'm right.

Expect to see that question play out on the public stage before the year is out. Better minds than yours or mine will determine which way it will get decided, but given how much we don't yet know about the CDS market, and the kinds of things that keep coming to light, I wouldn't yet place any bets on it either way. Well, unless that bet is a credit default swap.

You are correct that there is a lot we don't know about the CDS market. The legality of CDS contracts is not one of them. If you would like to support your contentions, feel free. Your next citation of support will be your first.

Sheesh. AIG has $400 billion in CDS outstanding, right? Can AIG redeem them? I'd say the answer is no without bailouts. Therefore they are worthless. In this reality the government is not voiding contracts, it is acknowledging they are unenforceable.

And signing a contract promising a payment that has no possibility of being fulfilled is perfectly legal? No fraud involved at all? Even if AIG knew they couldn't cover their positions? Try that one on the counterparties when they come looking for their money.

Ah, there are some good threads these days I just can’t stick around to respond or enjoy…

Hilzoy: OT, because I think OCSteve reads Malkin: I'm on the "secret liberal journalist cabal" she's talking about here:

Only rarely now, and then usually only when someone is pointing and laughing. But I do read HA which is a MM affiliate.

I would have been disappointed if you were not on the list. You are the liberal I respect most, so if this liberal group did not include you I would question their sanity. As it is, I just question their judgment. ;) They had to know this would come out and it just cements the “liberal MSM” meme. Like – 100% IMO. And this is my link for any “liberal MSM” point in the future. ;)

Still – I do get a kick out of the VRWC meme when we have pundit conf calls out of the WH every morning, this list with the (yes) liberal media, and Obama’s millions of minions on his em list… There has never been a more coordinated government response (propaganda) across the pundit class, politicos, and grassroots. Slick. But he’s still in campaign mode, not governing mode…

Sheesh. AIG has $400 billion in CDS outstanding, right? Can AIG redeem them? I'd say the answer is no without bailouts. Therefore they are worthless. In this reality the government is not voiding contracts, it is acknowledging they are unenforceable.

And signing a contract promising a payment that has no possibility of being fulfilled is perfectly legal? No fraud involved at all? Even if AIG knew they couldn't cover their positions? Try that one on the counterparties when they come looking for their money.

This is called bankruptcy. We all already know about it. I have said repeatedly that, if you want to avoid paying off the contracts, this is an available remedy. It is, in fact, the only such remedy. All of the redefining people are trying to do is pointless.

Of course, you are also going to throw out all of the regular insurance policies that AIG wrote if you do that. (This is aside from the problem of what other bankruptcies you would produce by wiping out the CDS.) AIG contracted liabilities. They have a certain amount of assets. Legally, there isn't distinction between the CDS they wrote, and the life insurance policies they wrote. If they're bankrupt, those are all contracts that they signed that they can't fulfill. In this regard, there's nothing special about the CDS.

Advocate bankruptcy if you want, but understand that that's what you are doing. Take time to think about all of the consequences of forcing AIG into liquidation, not just the ones that appeal to you. Lehman was, in the grand scheme of things, a pretty small investment bank. AIG is an order of magnitude bigger, and a hell of a lot more complicated. If you think that forcing AIG into bankruptcy will produce less disruption than Lehman's bankruptcy did, please explain why you think this is true.

If this listserv was like the one I run, it'd be quiet, well run and speaking with all one voice---because I rule it like a tyrant and am not afraid to use Moderator Power indiscriminately.

Somehow, I don't think this list is very quiet or very harmonious...

If you think that forcing AIG into bankruptcy will produce less disruption than Lehman's bankruptcy did, please explain why you think this is true.

I don't think we would be "forcing" anything. We would be allowing natural market forces to work their wonder. The same market forces AIG wunderkind were paid buckets of money to understand.

The question is whether we should continue to bail out AIG, which is significantly different than "forcing" AIG to do anything. AIG failed on its own. It does not need our help to be bankrupt.

I don't think we would be "forcing" anything. We would be allowing natural market forces to work their wonder. The same market forces AIG wunderkind were paid buckets of money to understand.

The question is whether we should continue to bail out AIG, which is significantly different than "forcing" AIG to do anything. AIG failed on its own. It does not need our help to be bankrupt

Hmmm....might it be more useful to say force AIG through bankruptcy proceedings? From what I gather, there's a real difference that could be made whether it's done now or a few months from now.

Advocate bankruptcy if you want, but understand that that's what you are doing.

No, you're advocating bankruptcy. I'm just advocating not giving money to screw-ups. If the counterparties want to try to enforce your iron-clad contracts with AIG, let them go for it. They are perfectly free to try to get $400 billion worth of blood from the AIG stone. The U.S. government can even help by buying all the non-CDS divisions of AIG (probably would cost less than $50 billion) and sending that money to the counterparties. Then the lawyers and the financial wizards can spend the rest of their lives in court arguing over the legality of the contracts and why the counterparties they defrauded shouldn't take everything they own.

TJ: I believe they're getting off easy.

Seppuku for all then. That will make us all feel better huh? I admit I would get a certain satisfaction if some of those actually responsible gutted themselves on Wall Street or threw themselves out of 30th story windows. If I looked at my 401(k) right before, I would likely award style points based on how they splattered on the pavement. Extra points for blood spatter beyond 30 feet.

I'm sorry, but I just cannot share in all of this outrage and think it is counterproductive. If you dont want the bonuses to be paid by taxpayers, then it is really very easy to insure that the bonuses dont come from taxpayer dollars. The Obama Admin has not yet given AIG the $30B additional they are to receive, presumably in exchange for another $30B of preferred stock. If taxpayers own 80% of AIG, then we simply need to discount 5 times the amount of the bonuses from the $30B and give them the lesser amount while still receiving $30B in preferred stock. If the bad bonuses are $100 million, then deduct $500 million and pay them only $29.5 for preferred stock worth $30B. The bonuses have now been paid by the owners of the other 20%. Problem solved.
And could we please stop saying that AIG got $180B of taxpayer dollars. Most of the money ($110B) is a loan from the Federal Reserve. It is not taxpayer money, its just the Federal Reserve creating $110B and loaning it to AIG. The remaining $70B is actually money borrowed on the credit of the United States. $40B during the Bush Administration and another $30B now. Taxpayers are paying interest on that money, probably about $2B a year and could be on the hook for repayment of any part of the debt that cannot be repaid from the money that will come from the sale of AIG's assets, and I believe that there will be full repayment as AIG owns very valuable insurance businesses. In fact, I think it likely we will get enough to cover the interest expense as well. Given all this, I also do not understand the outrage over 100% payments to counterparties. First, this was decided in the Bush Admin so its not Obama's fault, once its begun, he can hardly tell those who havent already been paid that they will get less than others got. Second, there are good reasons why the Federal Reserve and the Treasury might think it wise to pay 100% to municipalities and pension funds (thats our workers pensions) and foreign counterparties, since the Fed and Treasury want the same for US bondholders who own foreign bonds that other govts may be guaranteeing. Furthermore, we are in an ecomonmic crisis that threatens to get worse and this is all money being pumped into the economy, which should help it grow. In fact, who knows, the money might even get used to purchase government bonds that finance the stimulus.

If you want this problem cleaned up quickly, this is possibly the worst idea in history. The counter-parties will sue. In the end, they will win. In the meantime, we will spend years with this problem unresolved. The legal proceedings will be endless. Until they are finally settled, it will be just as if we had done nothing. All of the uncertainty we have today will carry on. All of the banks' inability to loan will keep going. There will be no useful financial industry.

Then, we'll have to pay out, plus interest.

You still haven't answered why you think AIG declaring bankruptcy wouldn't be worse than Lehman's was. You haven't even addressed the problem that refusing to honor AIG's derivative liabilities won't, by itself, cause more damage than the Lehman bankruptcy did. The AIG Financial Products Division alone has more assets than Lehman did.

The U.S. government can even help by buying all the non-CDS divisions of AIG (probably would cost less than $50 billion) and sending that money to the counterparties.

No. Again, we can't do this. You can not sever parts of a company to avoid bankruptcy. If there are assets available to pay the insurance policies, the derivative counter-parties have a claim on those assets. There is no functional difference between this suggestion and bankruptcy. They lead to the same results.

Then the lawyers and the financial wizards can spend the rest of their lives in court arguing over the legality of the contracts and why the counterparties they defrauded shouldn't take everything they own.

Yes, exactly. We can't get out of the financial crisis until the arguing is resolved. Uncertainty is a killer right now, and you are proposing that we should let it last for years.

Why is the comment system always editing out the first quotation in my posts? It is fine in preview, and then it disappears.

Seppuku for all then. That will make us all feel better huh?

Could be. But being badmouthed by Obama for being greedy SOBs is hardly equivalent to a death sentence. I'm sure their millions will assuage their hurt feelings.

Uncertainty is a killer right now, and you are proposing that we should let it last for years.

No. An insolvent issuer of CDS (bookie) and the insolvent banks that purchased those worthless CDS (the gamblers that serve as the bookie's clientele) are the problem. The problem is not uncertainty. The problem is that the global economy is collapsing under the weight of these fool counterparties leveraging 35 to 1 in order to gamble (through an insolvent bookie, no less) in the CDS "market" (I call it 'casino' but whatever).

It's not uncertainty, it's insolvency.

No. An insolvent issuer of CDS (bookie) and the insolvent banks that purchased those worthless CDS (the gamblers that serve as the bookie's clientele) are the problem. The problem is not uncertainty. The problem is that the global economy is collapsing under the weight of these fool counterparties leveraging 35 to 1 in order to gamble (through an insolvent bookie, no less) in the CDS "market" (I call it 'casino' but whatever).

It's not uncertainty, it's insolvency.

Then do you plan to answer the question of why you think an AIG bankruptcy wouldn't produce more dislocation than the Lehman filing did?

Now people are up in arms about the relative chicken feed promised to the very people that give AIG its value.

Bolds mine. Hard to know what to say.

Driving these people away will lead rapidly to AIG's failure

AIG, as it stands today, has already failed.

Yes, many lines of business are sound and are making money. Sadly, the financial products group managed to sell $440 billion worth of liability.

Seems to me that the CDS are not legally fraudulent. Under the terms of the law, they're an enforceable contract.

Thanks Phil Gramm!

It also seems to me that AIG has no hope in hell of fulfilling their contractual obligations to the counterparties.

In plain English, they don't have the dough.

I'll answer my own question from upthread.

Who will pay? I will pay, and you will pay. The US government is going to step in and manage the process of figuring out who is going to get paid, and in what amount, and is going to guarantee the debt so that the whole shooting match doesn't go up in flames.

I am going to pay, and you are going to pay, most likely to the tune of most of that $440 billion.

Not only that, but it's highly likely that after Obama, Frank, Schumer, Grassley, and the other 500 guys who want to go on record as being highly outraged are done with their dog and pony, you and I are going to pay millions of dollars in retention bonuses to the greedy pricks in AIGFP, who will then immediately quit and set up shop betting against their former employer.

Opportunity attracts opportunists.

We're going to pay for years. A lot of really important and valuable things are not going to be done because we're going to pay for this stupid crap.

Because the alternatives all appear to suck worse than writing a great big fat juicy check.

AIG is f'ing broke. They don't have the money.

If we tell the counterparties to pound sand, the whole game goes belly up. That's what they tell us, anyway.

So we will pay.

Read'em and weep.

The next person who tells me that its necessary for us to do this so that the highly skilled pricks in AIGFP don't all run away gets a kick in the nuts.

Because as soon as the checks clear, those cats are gonna be gone.

We have to pay them their bonuses so they don't go bet against AIG? WTF makes you think they're not doing that now, today?

If we can legally void their bonuses, I say do it. If not, pay them off. In the big picture it's noise. Imagine that.

Then cut them the f*ck loose and move on, because they are pirates.

Seppuku for all then.

No man, that's way too harsh.

Indentured servitude for them and all their progeny, until every last dime of the $440 billion is paid in full.

The next person who tells me that its necessary for us to do this so that the highly skilled pricks in AIGFP don't all run away gets a kick in the nuts.

Well, kick reality in the nuts then, because there's nobody else in this world who understand those $440 billion in liabilities. Paying a couple of hundred million to the only people who can help disarm that enormous ticking bomb is great value.

No one's paycheck is related to their worth as a human being or the 'importance' of their jobs -- otherwise kindergarten teachers would fly Lear jets. Your paycheck relates to your relative import with regard to the rest of the economy and, crucially, how replaceable you are. To quote Unforgiven: "deserve's got nothin' to do with it."

Today's lesson: if you screw up, it's best to screw up big, because then you're the only one who can put humpty-dumpty back together again.

there's nobody else in this world who understand those $440 billion in liabilities

If the financial janitors at AIG understood them, they wouldn't have f*cked up so badly that AIG had to go sucking at the teats of 300 million taxpayers. They are not precious derivative trading snowflakes. They are obscenely paid corporation destroying idiots at best, and penitentiary bound fraudsters at the most probable.

Paying a couple of hundred million to the only people who can help disarm that enormous ticking bomb is great value

How about this, next time the ticking bomb scenario comes up as a justification for waterboarding, you argue that instead, we should pay the terrorist hundreds of millions of dollars for his irreplaceable expertise in defusing the bomb he just set, and then send him back to the bomb factory for another year. Great argument. Brilliant. I don't see what could possibly go wrong.

Your paycheck relates to your relative import with regard to the rest of the economy and, crucially, how replaceable you are

AIG is paying some of those bonuses to EX-employees. Your argument makes no sense. "Gee, how could we find someone else to be an ex-employee for less than a million dollars". It is absurd, the lengths that people will go to justify the actions of the wealthy and privileged.

Today's lesson: if you screw up, it's best to screw up big

No, today's lesson comes from The Grifters:

All right, forget the long con. If the fool tips, you're caught. You'll do time. Never do time.

They're caught.

there's nobody else in this world who understand those $440 billion in liabilities.

I call shenanigans. These executive jagmoes don't understand those liabilities any more than the average reader on this blog.

If it were at all possible to see such a bet through, I'd give you 10,000 to 1 odds that any one of these AIG execs couldn't tell you in any substantive way what the hell sort of derivatives they are losing their shirts on right now.

I call shenanigans. These executive jagmoes don't understand those liabilities any more than the average reader on this blog.

Yeah, they do. Please explain to me what credit events trigger these things.

Yeah, they do. Please explain to me what credit events trigger these things.

Apparently they don't know them well enough to not bankrupt their company.

And they also missed the triggering events, or else they purposefully crashed the system.

So either they were useless, or malignant.

Apparently they don't know them well enough to not bankrupt their company.

And they also missed the triggering events, or else they purposefully crashed the system.

You are confusing the concept of, "Know what they are, and how they are written," with the idea, "They knew ahead of time that they were going to blow up." Those aren't the same things. I'd guess that these clowns have a decent idea of what they have, which is a lot more information than anyone else could get in short order. They were completely useless at assessing how risky the positions were.

That the risk was grotesquely mispriced is a tsunami under the bridge. It's passed, and the price it's now selling at is different. That's where we are.

Someone who has proven that they aren't any good at pricing the risk still might be a useful person to have around, because these liabilities still have to be dealt with somehow. Mispricing the risk working from models isn't the same as not being to trade them effectively if someone else is imposing risk limits on you and watching them. Your personal skills are important, but knowledge of the instruments is vital.

CDS aren't standardized. They aren't for set amounts. They are often on unusual bonds, or a basket of bonds. They are all triggered by a "credit event," but there are thousands of ways that that is defined in different deal. Some a phyisically settled, and most are cash settled. You have a certain period from the date of the credit event to settle, or you either forfeit the proceeds, or it goes back on the shelf waiting for another credit event. Some swaps have different credit events, triggered in different ways, demanding different responses. I could keep going on, but these contracts are written in dense legalese

Now, you need to unwind your position. That means paying someone to take the liability off your hands. That takes a working knowledge of how much they are worth. Some of these puppies have long, sharp teeth, too. They have a provision that it is the responsibility of the seller to notify the buyer that a credit event has occurred. If they don't, the buyer can let it slide, and, if it gets worse, exercise it in order to receive more cash.

If we throw the bums out and put newbies in, they're going to get run over. And, hey! Look! We finally have some customers driving up. Wait, don't they look like the guys we fired last week? But, they have an offer on the CDS for some super tranches, 2007 vintage MBS. How much is that worth? None of us know? So, do we sell it or not?

"Apparently they don't know them well enough to not bankrupt their company.

"And they also missed the triggering events, or else they purposefully crashed the system.

"So either they were useless, or malignant."

Took almost 24 hours, but jrudkis won the thread.

P.S. Hastingspete: Thank you for your (scary) personal insight into the Wall Street mentality. Further clarifies why we are witnessing so much populist outrage over the AIG scandal.

So you're saying that they'd be doing what former Countrywide officers are now doing with certain defaulted mortgages?

Someone is text totally misinforming Erick Erickson:

"I originally said Keith Olbermann and David Shuster of MSNBC were on it. Ezra Klein emailed me to deny that either were, but I have subsequently received additional information that both Kos from Daily Kos and David Shuster are on the email list."

Nope.

If we throw the bums out and put newbies in, they're going to get run over.

OK, then it's indentured servitude for them and their progeny. Or at least for the ones that aren't already gone.

And seriously, are you sure you want these people around? What guarantee do we have that they won't (or aren't already) betting against the deals they're supposed to be helping to resolve?

If they're keeping these folks around, they need to be on a leash.

Someone is text totally misinforming Erick Erickson

More fun than prank phone calls!

Whether or not AIG goes into bankruptcy is irrelevant. If CDS are the iron-clad will of God, the day after the bailout money stops the counterparties walk into a court and come out owning AIG in toto, bankruptcy or no. As far as I understand it.

Will AIG's failure be better than Lehman's? Sure. It's already $160 billion taxpayer dollars better. As TLTABQ says, we're not in this for AIG's benefit. We're keeping the counterparties afloat.

And as for the danger that the bonus wizards will leave AIG and use their insider knowledge to eat AIG's lunch, I will email my reply to whatever ISP you're using in your alternate universe.

Someone is text totally misinforming Erick Erickson

It occurs to me that this is yet another indication that Republicans don't understand the internet and possibly never will.

And as for the danger that the bonus wizards will leave AIG and use their insider knowledge to eat AIG's lunch, I will email my reply to whatever ISP you're using in your alternate universe.

Why are you confident that they will not?

The reason I raised the issue is that, way upthread, someone cited that as a reason for keeping them on. If that's true, it's not clear to me why keeping them on would prevent them from abusing their understanding of the trades.

So, if you don't mind, and purely for my own edification, what prevents them from gaming the situation?

Tom Maguire has a pretty good run down on this. A lot of links at his place, but to summarize some of his points:

-The 100% tax idea is just dumb. Many of these folks are not Americans. That would be the International part of AIG. And really – do you want Congress imposing taxes on specific individuals? I think plumbers make too much and that Joe guy p*ssed me off – tax the hell out of ‘em!

-Goldman Sachs – Why did AIG pay them so much?

-If they did not pay the $165M bonuses the legal liability looks like it would be $330M. While we’re slamming this company, think about how you as a major stakeholder would feel if they did such a dumb thing.

-“Finally, AIGFP was involved in profitable lines of business apart from credit derivatives. The management plan in March of 2008 was to ease out group head Joe Cassano (who had led the charge into credit derivatives) and keep the operation going by offering a retention pool of guaranteed bonuses (not incentive bonuses.) Plenty of people who stayed were neither Cassano acolytes nor involved in credit derivatives, so the current demonization is a bit misdirected.”

-Obama appointed officials looked at this issue, concluded there was no option but to pay out the bonuses, and *approved* this. Let’s repeat that: Obama appointed officials. Now Obama is personally demonizing individuals for getting the money his appointees approved paying out.

-“If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right.”

-“AIG's Financial Products unit has been overseen for years by an SEC-approved monitor. And AIG didn't just make disastrous bets on housing using those infamous credit default swaps. AIG made the same stupid bets on housing using money in its securities lending program, which was heavily regulated at the state level. State, foreign and various U.S. federal regulators were all looking over AIG's shoulder and approving the bad housing bets.“


My own thoughts:

-Why did they pay out to all those foreign banks? Is the US taxpayer supposed to be the only one footing this bill? Did Deutsche Bank take the same dumb risks as US companies or not? I understand they dabbled a bit in derivatives. Why did AIG pay them $6B? When did Josef Ackermann last get a bonus and how much was it? To his credit he passed on his 08 bonus. But in 07, when this mess was being mostly covered up by those in the know “the bank's four directors received a bonus totaling 33.2 million euros ($43.3 million), 14 million euros of which went into Ackermann's pocket.” Sweet!


-Again, these were not performance bonuses. They were retention bonuses, deferred compensation, money that was owed.

Finally:
Could be. But being badmouthed by Obama for being greedy SOBs is hardly equivalent to a death sentence.

Let’s hope not. The President of the United States is currently demonizing individuals, possibly inciting someone to violence. It doesn’t take much imagination to picture someone destitute by this economy deciding to end it all and take as many Wall Street types with him as he can. Yes – I will hold Obama’s rhetoric responsible for that if it happens.

Why are you confident that they will not?

If they can do it, more power to them. But I feel fairly confident that those wizards are not going to be able to:

1. Borrow a couple of billion from somebody.

2. Buy a whole lot of AIG CDS at bargain basement prices, when at this point they are little more than IOUs from the feds.

3. Convince someone else to buy them back at a profit, on the theory that they're so good that they can figure out a way the owner will only owe half of the original money to the counterparties.

If we're talking about CDOs I might be worried. Not CDS.

Or alternatively:

1. Write a bunch of new CDS against AIG's CDS, based on their insider knowledge.

2. Dredge up a new bunch of suckers to bye them.

OK by me. Doubt they can pull it off.

How much gaming of the system could they do from jail? For fraud, extortion, racketeering, and whatever else can be thrown at them?

A couple of the points in the NY Times DealBook 'Seven Sad Truths About AIG' were also made yesterday by Eliot Spitzer, notably the billions in back-door wealth transfer effected by paying off the counterparties at 100% of face value rather than current market price.

That involves the handover of a lot more money than is involved in the bonuses, and directly raises unsettling and still unanswered questions at the heart of the bailout itself: what's the strategy exactly, how are we going to know when/if it's working, and why the hell are we being told so little when we're footing the bill?

Not that there's not a lot that stinks about the "retention" bonuses: Quite a few were made to people who've already left, no apparent effort has been put into looking into what AIG execs knew and when they knew it about the fraudulent or unsustainable aspects of the Financial Products division despite the resignation of the auditor who Cassano prevented from looking at the books, the bonuses were arranged for during a period when the company might have seen what was coming and some of the contracts require payment at the 2007 level (making the connection with "performance" meaningless and making them look more like the blackmail many here suspect they are), and more.

The perfect storm of outrage:
Genuine anger by suffering people. Bonus news trickling out ahead of the much bigger counterparty theft, so that media orchestration of genuine popular anger screens it nicely. Total failure by Geithner, Obama, and all the political team to anticipate how people would react, with appalling after-scramble: not-particularly-convincing Obama huffing for teevee accompanied by deceitful, slimy WH campaign to blame it on Sen. Dodd.

Why did they pay out to all those foreign banks?

I refer you to TLTABQ's comment upthread.

That involves the handover of a lot more money than is involved in the bonuses, and directly raises unsettling and still unanswered questions at the heart of the bailout itself: what's the strategy exactly, how are we going to know when/if it's working, and why the hell are we being told so little when we're footing the bill?

Again, I find TLTABQ's speculations good. Right or wrong, they're afraid of:

European banking collapse -> Total banking collapse -> big time war.

They're keeping it secret because the U.S. is going to pay for it all (at least at first). And the not-wealthy publics are going to get really, really pissed about it. And there might be an actual class war if they get pissed enough. Not a GOP faux class war, either.

Paying out to counterparties is the point of the bailout.

That said, it is certainly time to start asking whether the administration really has a coherent plan, because right now they just seem erratic and responsive to events. I gave some dough to Obama's election campaign, but as OCSteve points out, his decision to indulge in vilifying the recipients of these bonuses is deplorable. He's not supposed to be running for election anymore. Does he want to redress the massive structural problems in the financial system and the economy, or does he want to run around indulging in demagoguery over sums of money which, in light of the bigger picture, are rounding errors?

Unless he's just a craven opportunist and unable to leave an election mentality behind, then I would think Obama is indulging the demagoguery on this issue because he intends to come back to congress for a lot more money for bailouts and/or stimulus plans in the future, and he is aware that the pitchfork-mentality taking hold jeopardizes that. That's the only positive interpretation I can come up with for his recent behaviour.

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